Two years after a congressionally appointed commission published its findings on the causes of the financial crash of 2008 that led to the Great Recession, government agencies are going after one of the cogs.

On Tuesday, California charged Standard & Poor's, the nation's largest credit rating agency, with fraudulent practices that resulted in close to $1 billion of losses incurred by the California Public Employees' Retirement System, the California State Teachers' Retirement System and other institutional investors in the state.

About 15 other states are also suing S&P, as is the U.S. Justice Department, which is seeking up to $5 billion in civil fraud damages relating to the stamp of approval the firm gave to mortgage-backed securities in the mid-2000s that turned out to be dogs.

The suits allege that S&P misrepresented the credit-worthiness of some $4 trillion worth of securities it rated between 2004 and 2007, and deliberately "downplayed and disregarded the true extent of the credit risks," according to the Justice Department.

"It was all about revenue," said the Financial Crisis Inquiry Commission's chairman, Phil Angelides, referring to fees of up to $500,000 investment banks paid S&P and other government-anointed agencies to have their securities rated (naturally, the higher the better). "They were corrupted by the hunger for market share."

One obvious question arising from this week's actions: What took the government so long? Alarm bells about the ratings agencies' activities started ringing in 2007 and have been recounted in numerous studies of America's financial collapse since. S&P and two other ratings agencies, Fitch Ratings and Moody's, have been named in a number of private lawsuits, including one that CalPERS settled with Fitch Ratings (owned by Hearst Corp., which also owns The Chronicle) in 2010, although no money changed hands. Its lawsuits against Moody's and S&P are still pending. So far, however, neither the federal government nor the states have filed civil suits against Moody's or Fitch Ratings.

Long investigation

"We welcome the AG's efforts to hold S&P accountable for their rating methodologies that resulted in significant losses to California's public pension funds and other investors," said CalPERS spokesman Brad Pacheco. "A recovery from S&P will benefit the millions of public employees that rely on us for their retirement security."

The California investigation began in May 2011, under the auspices of Attorney General Kamala Harris' California Mortgage Fraud Strike Force. In the 20 months since then investigators have been studying "millions of documents, identifying individual securities and issuing dozens of subpoenas," said Michael Troncoso, senior counsel to the attorney general. Only in the past few weeks has his office been coordinating with the Justice Department and other states, he said.

"Our philosophy is, when you file a case, you must be ready to try it," he said. "You have to be diligent."

According to the California lawsuit, filed under the state's False Claims Act and other statutes, CalPERS lost $778 million on approximately 100 individual securities rated AAA by S&P. The teachers' retirement system lost $39.5 million on 10 securities rated AAA by S&P. Not a lot compared to CalPERS - the teachers' pension fund has not commented on the suit - but every bit of recompense will help the fund, which on Tuesday reported it will need an extra $4.5 billion a year to meet long-term obligations.

Disputing the charges

S&P disputes the charges. "Claims that we deliberately kept ratings high when we knew they should be lower are simply not true," the company said. "Unfortunately, S&P, like everyone else, did not predict the speed and severity of the coming crisis and how credit quality would ultimately be affected."

S&P's attorney, First Amendment champion Floyd Abrams, charged in an interview with CNBC that the federal government's investigation (which began in 2009) "significantly increased" after S&P downgraded the government's credit rating in 2011. "We don't know why," he said.

Abrams said he would not use a First Amendment defense in the case, although ratings agencies in the past have said their ratings are merely opinions, and therefore constitutionally protected free speech. In three recent court cases, including one involving CalPERS against Moody's and S&P, judges have rejected the free speech defense.

The "who knew?" defense could be equally problematic. Both the Justice Department and California suits contain internal e-mails and memos from S&P executives suggesting they knew not all was hunky-dory with the validity of its ratings.

"This market is a wildly spinning top which is going to end badly," one executive wrote in 2006. Others wrote of using "magic numbers" and a "coin toss." A ditty to the tune of Talking Heads' "Burning Down the House" circulated among the staff, with lines like, "Watch out! Subprime is boiling over/Bringing down the house."

In a July 2007 investor conference call, according to the Financial Crisis Inquiry Commission, one of the firm's managing directors was asked why it was starting to make noises about downgrading some securities. "Why now? I mean, the news has been out on subprime now for many, many months. I mean, it can't be that all of a sudden, the performance has reached a level where you've woken up."

"We heard from many people inside the ratings agency that the process was being subverted," said Angelides, a former California treasurer.

Talks break down

Settlement talks between S&P and its government pursuers reportedly broke down when the rating agency balked at the amount of damages on the table and the Justice Department's insistence that S&P admit to wrongdoing. Most financial institutions caught up in post-recession litigation have managed to avoid admitting wrongdoing. Troncoso would not comment on the negotiations, beyond confirming that California has participated in them.

"I'm not a lawyer," said Angelides, commenting on the S&P case. "But we heard pretty damning evidence. It's clear that the ratings should never have been put into the marketplace. They didn't just hurt investors who relied on the good faith of the agencies. There's the collateral damage caused by their contribution to a bubble that burst."